Trading Venues Research Articles

Optimal Order Exposure in a Limit Order Market

Hidden orders are offered by many lit trading venues for participants to hide the true size of their orders. To help a risk-neutral trader executing a target volume to minimize the execution cost by benefitting from the setting of a limit order market allowing hidden orders, we propose a multi-stage dynamic programming model to determine the optimal placement of limit and hidden orders. We obtain the analytical solution to this model under certain assumptions and discuss economic implications of our results. We use order-message data from NASDAQ to estimate the model parameters and demonstrate the generality of our assumptions. Our analytical solutions together with numerical experiments suggest an optimal execution pattern that the trader should submit hidden orders at early stages, possibly turn to a mixture of limit and hidden orders later, and use limit orders only when the execution deadline is approaching.

Shades of darkness: A pecking order of trading venues

We characterize the dynamic fragmentation of U.S. equity markets using a unique data set that disaggregates dark transactions by venue types. The “pecking order” hypothesis of trading venues states that investors “sort” various venue types, putting low-cost-low-immediacy venues on top and high-cost-high-immediacy venues at the bottom. Hence, midpoint dark pools on top, non-midpoint dark pools in the middle, and lit markets at the bottom. As predicted, following VIX shocks, macroeconomic news, and firms’ earnings surprises, changes in venue market shares become progressively more positive (or less negative) down the pecking order. We further document heterogeneity across dark venue types and stock size groups.

The Effect of the Pit Closure on Futures Trading

Motivated by the Chicago Mercantile Exchange’s (CME) decision to close down most of the futures pits in July of 2015, we analyze how this event may have affected the livestock and treasury futures markets. We find that although the already declining futures pit trading decreased further after the pit closure, it has not completely disappeared. Execution costs, following the pit closure, appear to have increased for livestock futures and declined for treasury futures transactions on the electronic platform. We, also, find that pit users, who had been active in both trading venues, remain active in the electronic market. However, there is no evidence of pit traders (locals) transitioning to the electronic market. Nevertheless, some of them are still active in options pits. When we explore the changes in daily trading patterns, we observe an ongoing shift in the timing of trading hours for livestock futures, but we note that this shift is unlikely to be driven by the pit closure.

Managing Excess Volatility: Design and Effectiveness of Circuit Breakers

We investigate different designs of circuit breakers implemented on European trading venues and examine their effectiveness to manage excess volatility and to preserve liquidity. Specifically, we empirically analyze volatility and liquidity around volatility interruptions implemented on the German and Spanish stock market which differ regarding specific design parameters. We find that volatility interruptions in general significantly decrease volatility in the post interruption phase. Unfortunately, this decrease in volatility comes at the cost of decreased liquidity. Regarding design parameters, we find tighter price ranges and shorter durations to support volatility interruptions in achieving their goals.

The Real Effects of NASDAQ Delistings

It is claimed that exchange listing of its stock benefits a firm by improving its stock liquidity and access to capital, thereby affecting real decisions and consequent outcome variables. Testing this claim empirically encounters obvious and formidable endogeneity problems. This paper empirically examines the causal effect of involuntary delisting from a stock exchange on stock liquidity, access to capital, corporate investment and profitability. Focusing on firms in violation of NASDAQ continued listing rules between 2000 and 2009, I compare firms that eventually delisted and moved trading of their stock to OTC markets with those that regained compliance and remained on NASDAQ. Market volatility during the delisting grace period is used as an instrumental variable (IV) for the delisting outcome. My findings suggest the following: First, delisting causes stocks to experience reduced daily trading volume, but only if the stock was actively traded prior to delisting; for thinly-traded stocks, there is no effect. Second, surprisingly, the number of investors, institutional ownership or analyst coverage are not affected by delisting. Third, delisting leads to less future equity issuance only if a stock was actively traded prior to delisting. Fourth, delisting has no statistically significant effect on a firm's long-term investments. Fifth, delisting improves long-term gross margin for firms which were thinly-traded prior to delisting. Sixth, delisting does not have statistically significant effect on firm value. Overall, my findings indicate that delisting from a stock exchange is not as costly as commonly believed. This implies that the OTC markets may provide small firms that have limited trading volume with a low-cost, effective market for their stock. My conclusions support the recent policy initiations to provide the alternative listing and trading venues for small public companies.

Sgx Bids for Asx

In October 2010, the recently appointed CEO of the Singapore Exchange (SGX) wanted the SGX to grow faster than organic growth alone would allow. The most logical acquisition target was the Australian Securities Exchange (ASX). Executives from the SGX and the ASX announced an agreement to merge. The two exchanges would remain separate legal entities for regulatory purposes but both would be owned by ASX‐SGX Limited, a new holding company that the deal would establish. But why did the merger fail? This left executives at the SGX and other foreign securities exchanges pondering whether the conditions the Australian Treasurer specified for a merger could ever be met and, if so, would a foreign securities exchange really be allowed to acquire the ASX? Excerpt UVA-F-1756 Rev. Jul. 21, 2016 SGX Bids for ASX It was October 2010, and the recently appointed CEO of the Singapore Exchange (SGX) wanted the SGX to grow faster than organic growth alone would allow. Although Singapore was an important world financial capital and a very prosperous city‐state, its small population of 5 million limited potential growth from the domestic economy alone. At the same time, changes in the ownership structure of exchanges, coupled with a shift to electronic trading and increased competition from new trading venues, had sparked a wave of exchange mergers and attempted mergers around the world since the turn of the century. Acquiring another exchange could achieve the SGX's desired growth and realize significant cost and revenue synergies while increasing the SGX's relative importance in a consolidating industry. The problem that the SGX faced was that there were only a few potential acquisition targets in the Asia‐Pacific region, as most countries in the region would not allow a domestic securities exchange to be acquired by a foreign one in a cross‐border merger. . . .

Ensuring Market Integrity and Stability: Circuit Breakers on International Trading Venues

Circuit breakers are important mechanisms used to prevent excess short-term volatility and to ensure price continuity. This article presents the results of an international survey on the design and application of circuit breakers on trading venues worldwide. The majority (86%) of the responding trading venues apply circuit breakers and thereby aim to ensure investor protection and increase market integrity and stability. On cash markets, market-wide trading halts and volatility interruptions are the most prevalent types of circuit breakers (72%). On derivatives markets, most exchanges coordinate their circuit breaker with their cash market (40%), followed by marketwide trading halts (20%) and volatility interruptions (13%). Most circuit breakers do not differentiate between upward and downward market movements. There is also support for greater coordination of circuit breakers across venues, and a few exchanges (32%) already coordinate their circuit breakers with other venues. <b>TOPICS:</b>Exchanges/markets/clearinghouses, global

Optimal Off-Exchange Execution with Closing Price

The purpose of this paper is to examine whether the closing price guaranteed execution is possible contract, and if possible, how an institutional investor who affects the security price allocates execution volumes to both traditional trading and off-exchange (over-the-counter, OTC) trading venues. With a generalized price model at the traditional venue which considers the permanent impact effect explicitly, we derive an optimal execution strategy in the traditional trading venue and the allocation of the order volume to both venues in the framework of dynamic programming. By proving that an optimal execution strategy is in the static class, we further show that the closing price guaranteed contract may be established and the trading volume at the time of agreement of the contract can be controlled. Moreover, by some numerical examples, we illustrate a possibility for the institutional investor to manipulate the market in order to seek a profit under some trading situation.

INVESTICINIŲ PAVEDIMŲ PRIĖMIMO, PERDAVIMO IR VYKDYMO CIVILINIS TEISINIS KVALIFIKAVIMAS

Šiame straipsnyje analizuojama finansų maklerių teikiamų klasikinių investicinių paslaugų – investicinių pavedimų priėmimo, perdavimo ir vykdymo civilinė teisinė prigimtis ir atliekamas jų priskyrimas tam tikriems Lietuvos privatinės teisės institutams.

Are High-Frequency Traders Anticipating the Order Flow? Cross-Venue Evidence from the UK Market

There have been allegations that high-frequency traders prey on other participants making profits taking no or minimal risk in the process by predicting with near certainty where orders will be routed. We investigate whether there is evidence of this happening systematically in the UK equity market. We examine whether high-frequency traders exploit their milliseconds latency advantages to anticipate orders arriving in quick succession at different trading venues. We also analyze whether they can anticipate the order flow over longer timeframes. We do not find evidence that the first behavior is occurring systematically in UK markets. We find patterns consistent with the later but we cannot say whether this is due to them reacting faster to information.

The Value of a Millisecond: Harnessing Information in Fast, Fragmented Markets

We examine the introduction of a speed-bump by an existing exchange which provides certain participants with guaranteed speed advantages. A selective order processing delay for market orders on TSX Alpha allows low-latency liquidity providers to avoid adverse selection through their ability to react to activity on other venues. These changes increase profits for liquidity providers on TSX Alpha but negatively impact aggregate liquidity: market-wide costs for liquidity demanders increase, with liquidity suppliers’ profits reduced across remaining venues. Our findings have implications for the speed bump debate in the United States, speed differentials more generally, as well as the regulation of market linkages across fragmented trading venues.

COMPETITION BETWEEN EQUITY MARKETS: A REVIEW OF THE CONSOLIDATION VERSUS FRAGMENTATION DEBATE

AbstractTechnological advances and regulatory initiatives have led to the emergence of a competitive, but fragmented, equity trading landscape in several markets around the world. While these changes have coincided with benefits like reduced transaction costs, advancements in trading technology, and access to a diverse array of execution venues, regulators and market participants have also raised concerns about the welfare implications of innovations like dark pools as well as the resulting increase in execution complexity. Exchanges are often viewed as natural monopolies due to the presence of network externalities and economies of scale. However, heterogeneity in traders' preferences means that no single venue can serve the interests of all investors. Fragmentation of the marketplace can be seen as a direct outcome of this heterogeneity. In this paper, we review the theoretical and empirical literature examining the economic arguments and motivations underlying market fragmentation, the resulting implications for liquidity and price efficiency, and the role for public policy. Beyond the concerns for equity markets, the lessons from this literature are relevant for other asset classes experiencing an increase in competition between trading venues.

Spoilt for Choice: Order Routing Decisions in Fragmented Equity Markets

The equity trading landscape all over the world has changed dramatically in recent years. We have witnessed the advent of new trading venues and significant changes in the market shares of existing ones. We use an extensive panel dataset from the European equity markets to analyze the market shares of five categories of lit and dark trading mechanisms. Market design features, such as minimum tick size, immediacy and anonymity; market conditions, such as liquidity and volatility; and the informational environment have distinct implications for order routing decisions and trading venues' resulting market shares. Furthermore, these implications differ distinctly for small and large trades, probably because traders jointly optimize their trade size and venue choice. Our results both confirm and go beyond current theoretical predictions on trading in fragmented markets.

The Anatomy of the CDS Market

Using novel position and trading data for single-name corporate credit default swaps (CDSs), we provide evidence that CDS markets emerge as alternative trading venues that serve a standardization and liquidity role. CDS positions and trading volume are larger for firms with bonds that are fragmented into many separate issues and have heterogeneous contractual terms. Whereas hedging motives are associated with trading volume in the bond and CDS markets, speculative trading concentrates in the CDS. Cross-market arbitrage links the CDS and bond market via the basis trade, impressing the negative CDS-bond basis and reducing price impact in the bond market.

Informed Trading in Hybrid Bond Markets

This paper studies the effects of pre-trade transparency on the price discovery process by investigating the choice of trading venue and order type by informed dealers who can choose between an electronic limit order book (LOB) and the over-the-counter (OTC) market. A detailed data set from the hybrid Norwegian government bond market shows that informed dealers, defined as dealers whose order flows predict bond excess returns, prefer market orders in the LOB. The results further show that uninformed dealers tend to provide liquidity to informed dealers in the LOB. Informed dealers' preference for speed can reflect that limit orders are exposed to high waiting costs in markets with infrequent trading and that OTC trades are exposed to a costly leakage of information in markets dominated by a few central dealers.

Global Investment Environment of the Post‐Quantitative Easing World: The ‘new‐old’ and ‘new‐new’ Normal

AbstractGlobal markets since late 2007 are not ‘normal’, where normal means market conditions we would expect to observe going forward in the absence of any new economic shocks. Financial markets have been dominated by extraordinary central bank policies that were created to deal with challenging market conditions reflecting heightened risk aversion and illiquidity. Markets in the future will have some characteristics that look more like the market conditions observed in the pre‐crisis period, which I call the ‘new‐old normal’ and other conditions that differ from the past, which I call the ‘new‐new normal’. I first review what happened during the financial crisis in terms of developments in three asset classes, equities, fixed income and currencies, to place the forward‐looking view in proper context. Then the transition period from the quantitative easing (QE) era of exceptional monetary policy to post‐QE markets is discussed. Post‐transition, we will see some features of the post‐QE world that will resemble pre‐crisis market conditions, the ‘new‐old normal’ with higher policy interest rates, wider cross‐country interest differentials, lower cross‐asset return correlations and a resurgence of the importance of cross‐country differences in fundamentals in international investing. However, some features of the post‐QE investment environment will be unlike anything observed in the past: the ‘new‐new normal’ with reduced liquidity and more days of exceptionally large volatility and asset price moves due to regulatory effects resulting in a reduced ability of market‐makers to provide inventory buffers for counterparties and electronic trading venues that shut down trading in high volatility periods; low inflation; flatter yield curves; and emerging markets providing less opportunity for diversification gains as they converge to developed financial market characteristics.

A Theory of High Frequency Market Making in Fragmented Markets

I examine the impact of high frequency (“fast”) market making on liquidity, price discovery and institutional traders’ returns in a setting with market fragmentation. Faster market makers more precisely monitor orderflows across trading venues than slower market makers. If every market maker’s speed increases, I find that liquidity and price discovery improve at all trading venues while institutional traders’ returns decline. When the market makers’ speeds increase at a specific trading venue, liquidity and price discovery at that venue improve and spillovers affect the other venues. If the market makers at the other trading venues are sufficiently slow, the spillovers positively affect liquidity and price discovery at those venues; otherwise, the spillovers harm liquidity and price discovery.

The evolution of market share among the U.S. options market platforms

Abstract The U.S. equity options market has shown rapid growth, characterized by increased trading volume and new entrants in recent years. As competition in the options market has intensified, each trading venue has attempted to differentiate itself with a unique value proposition aimed at gaining market share. Using a sample that covers key events including the introduction of two new trading venues, we analyze the competition for trading volume, investigate the characteristics of trades and execution costs on the exchanges and examine the evolution of market share in the options industry. We find that exchange market share is positively related to execution quality and quote competition indicators and negatively related to execution costs, while exchanges that use the maker–taker model as their primary pricing model account for, on average, a lower market share than exchanges that use alternative pricing models. Given that exchanges increasingly compete using innovative methods involving market structure such as different order types, fee structures, pricing methods, and priority rules for matching orders, our finding that higher market quality in the form of higher execution quality, lower execution costs, and competitive quotes translates into higher market share is especially noteworthy.

Broker Routing Decisions in Limit Order Markets

Many investors do not access equity markets directly; instead, they rely on a broker who receives their order and submits it to a trading venue. Brokers face a conflict of interest when the commissions they receive from investors differ from the costs imposed by different trading venues. Investors want their orders to be filled with the highest probability, while brokers choose venues in order to maximize their own profits. I construct a model of limit order trading in which brokers serve as an agent for investors who wish to access equity markets. When routing liquidity taking orders (market orders), brokers preferentially route to venues with lower fees, driving up the execution probability at these venues and lowering adverse selection costs. However, when routing liquidity supplying orders (limit orders), if routing decisions are driven primarily by rebates from the exchanges, investors suffer from lower execution probability and higher costs of adverse selection. I find that when rebates for making liquidity are sufficiently similar across venues, routing decisions will be driven by the higher execution probability, while if rebates are sufficiently different, routing will be driven by rebates.

Analyst coverage: Does the listing location really matter?

Using a count panel regression method, we find that the listing location really does matter as stocks listed on the main board (FTSE350) rather than the junior market (AIM) attract more analyst coverage than can be explained by existing factors, even when we control for listing requirements and the type of cross-listing. We also find that listing requirements have a significantly greater impact on the number of analysts following AIM companies rather than their FTSE350 counterparts. Moreover, pooling stocks from different listing locations can conceal additional differences in the determinates of analyst services for the main board and junior markets. For example, cross-listing on a stock exchange increases analysts coverage for FTSE350 stocks but not AIM stocks and listing on less transparent trading venues such as over the counter and alternative trading systems (dark pools) decreases analyst coverage, especially for AIM stocks.